Stocks close modestly lower to end a dismal year

Do not take yearly results too seriously. Instead, focus on four or five-year averages. – Warren Buffett

Although the official Santa Claus rally period doesn’t officially end until after the first two trading days of the new year, it looks like the Grinch may instead steal any happiness that investors may have enjoyed in an otherwise dismal year in the stock market. All three major stock averages closed modestly lower with losses of less than one percent last week as stocks turned in their worst performance since 2008. The bond market didn’t fare very well, either, as the yield on the 10-year Treasury rose to 3.8% as oil prices hit a 3-week high after China announced that it was easing Covid restrictions. After starting the year at about 1.5%, the surge in the 10-year Treasury yield also caused the bond market to suffer one of its worst years in decades as the Federal Reserve aggressively raised interest rates to combat high inflation. A combination of tax loss selling, portfolio rebalancing and investors deciding where to position portfolios for 2023 also weighed on sentiment last week. As is usually the case in a holiday-shortened week, trading volumes were light and there was little in the way of either corporate earnings reports or economic data for investors to trade on. The next period that Wall Street will be watching closely is how the stock market performs in the first five trading days of the new year. Since 1929, when the stock market has posted a positive return in the first five trading days of the year, it has gone on to post gains for the full year 75% of the time, with an average gain of nearly 12%. The predictability of the market when stocks decline during this period is much less reliable. While the so-called Santa Claus rally and the January effect are interesting and make for good reading, what really matters for investors will be the fundamentals, namely economic data and corporate earnings, since they ultimately will determine where the stock market is headed in 2023.

Last Week

Housing data was again the focus last week as pending home sales in November fell far more than expected, falling for the 6^th straight month, as they recorded the lowest reading since the pending home sale index was launched in 2001. Higher mortgage rates were largely responsible for the drop in the number of signed contracts to buy a home. The S&P Case-Shiller Index for home prices fell in October for the 4^th consecutive month and the housing market will likely slow further in the coming year as the Federal Reserve continues to tighten. Weekly jobless claims were 225,000, an increase of 9,000 from the previous week and above estimates of 223,000. The Chicago Purchasing Manager’s Index (PMI) in December was better than expected but was still below the 50 threshold, which indicates contraction.

For the week, the Dow Jones Industrial Average fell 0.2% to close at 33,147 while the S&P 500 Index lost 0.1% to close at 3,839. The Nasdaq Composite Index declined 0.3% to close at 10,466.

This Week

The December employment report is expected to show that about 220,000 new jobs were created and that the unemployment rate remains unchanged at 3.7%. The ADP report is forecast to show that about 145,000 private-sector jobs were added in December after a 127,000 gain in November. Both November construction spending and factory orders are expected to decline modestly.

The only notable companies scheduled to report third quarter earnings this week are Conagra Brands, Constellation Brands and Walgreens.

Portfolio Strategy

While it’s been a tough year for both the stock market and the bond market, there are now plenty of opportunities for income-oriented investors to find attractive yields. Dividend yields have risen as stocks have declined and the Bloomberg Barclays U.S. Aggregate Bond Index dropped 13% last year, allowing investors to earn positive inflation-adjusted returns on bonds provided inflation continues to moderate. (Bond prices and yields move in opposite directions). For stocks, the iShares High Dividend ETF (HDV) yields 4.0% and the Vanguard High Dividend Yield ETF (VYM) yields approximately 3% as it ended last year unchanged, including dividends, compared to a negative total return of 18% for the S&P 500 Index. Funds that invest in companies with a history of increasing their dividends every year also offer investors a way of generating better returns that can keep pace with inflation. The ProShares S&P 500 Dividend Aristocrats Index ETF (NOBL) and the Vanguard Dividend Appreciation Index ETF (VIG) are two examples of funds with higher yields than the S&P 500 and the added benefit of those dividends increasing every year. For alternative investments, the Vanguard REIT Index (VNQ), which invests in holding companies that own real property such as apartment buildings, hotels, shopping centers, health care facilities, storage facilities and office buildings, yields nearly 4%. For fixed income investments, the JP Morgan Ultra-Short Income ETF (JPST) and the Vanguard Ultra-Short Bond ETF (VUSB) offer yields in excess of 4% and average maturities of less than one year, making them a relatively safe choice in the event that inflation remains high and the Federal Reserve is forced to continue to raise interest rates. For those investors in a high tax bracket, municipal bonds also offer attractive levels of income as their yields are near their highs of the past decade.